4. Retained earnings statement
The purpose of the retained earnings statement is to measure the accumulated profit for all historical periods that have been reinvested into the company rather than paid out to the owners.
The dividends paid out represent payments to the owners. After the dividend payments are subtracted, the result is the ending value of retained earnings for the period.
Start-ups do typically not pay dividends but reinvest profits to finance growth initiatives.
Companies can also have negative values for retained earnings if they have lost or taken out more money than they have earned and reinvested.
The calculation adds each period’s net income to retained earnings, and cash flow is not a part of this equation. This is because retained earnings concern the profit that is recorded through accrual accounting and not cash flows.
Shareholder’s equity is a crucial component of the balance sheet, and retained earnings is a major part of shareholder’s equity. Without the correct calculation of retained earnings, the balance sheet will not balance.